RBI Plans To Curb Liquidity Overhang Ahead Of Festive Season, Asks Banks To Keep 10% CRR From August 12

Apart from turning hawkish and raising inflation targets, the banking system's excess liquidity was also on the list of RBI's policy outcomes. On Thursday, RBI governor Shaktikanta Das asked scheduled commercial banks (SCBs) to maintain an incremental cash reserve ratio (I-CRR) of 10% with effect from August 12 to manage liquidity overhang that has been generated by various factors including the return of Rs 2000 banknotes into the system.

In the governor's statement, Das said, "In recent years, our stated stance on liquidity is to maintain adequate liquidity in the system to meet the productive requirements of the economy. Excessive liquidity, on the other hand, can pose risks to price stability and also to financial stability. Hence, efficient liquidity management requires continuous assessment of the level of surplus liquidity so that additional measures are taken as and when necessary to impound the element of excess liquidity."

Accordingly, RBI has decided that with effect from the fortnight beginning August 12, 2023, scheduled banks shall maintain an incremental cash reserve ratio (I-CRR) of 10% on the increase in their net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023.

Further, Das said, "This measure is intended to absorb the surplus liquidity generated by various factors referred to earlier including
the return of ₹2000 notes to the banking system."

It needs to be noted that 10% incremental CRR is a temporary move.

"This is purely a temporary measure for managing the liquidity overhang. Even after this temporary impounding, there will be adequate liquidity in the system to meet the credit needs of the economy," Das added.

RBI will review the I-CRR on September 8, 2023, or earlier to return the impounded funds to the banking system ahead of the festival season.

The RBI governor added that the existing cash reserve ratio (CRR) remains unchanged at 4.5%.

On the banking systems liquidity, Sujan Hajra, Chief Economist & Executive Director, Anand Rathi Shares and Stock Brokers said, "The temporary incremental CRR increase is a reaction to the sharp increase in systemic liquidity overhang, which is attributed primarily to the demonetization of Rs.2,000 notes. We expect this measure to be reversed as systemic liquidity approaches balance. At the same time, we believe that by maintaining its liquidity tightening stance, the RBI maintained its concern about upside inflation risk."

Additionally, Hajra added, "The CRR hike would temporarily drain out liquidity close to Rs.700 billion. The systemic liquidity would still be in surplus. Consequently, the impact would be largely neutral for banks. This in fact would be positive for NBFCs as the short/term interest rate would be lower than what was being anticipated earlier."

Further, Bhavik Thakkar CEO of Abans Investment Managers explained that 10% CRR on incremental deposits would mean -- for example -- for every Rs 100 incremental deposit received, banks have to keep ₹10 in cash compared to ₹4 usually required.

Thakkar added, "Although this is short-term measure to control liquidity, the message it provides is that getting into festive season, RBI is controlling money supply which is usually high during festive season and could also lead to further inflation which seems to be key focus for RBI over Economic Growth."

From June to July, the daily absorption of liquidity under the LAF averaged Rs 1.8 lakh crore, up from Rs 1.7 lakh crore in April to May 2023. While Money supply (M3) expanded by 10.6% y-o-y as on July 28, 2023, as against 10.1% on May 19, 2023.

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